Why you should care

Tightening credit is casting a shadow over the future of a series of global investments made by Chinese companies.

By Don Weinland

The Daily DoseFEB 11 2019

After spending half a decade buying up farmland across central France, Chinese billionaire Hu Keqin is coming under pressure to sell some of it off. Reward Group, his milk formula and household chemicals company, had big plans to import wheat grown in France and serve up fresh-from-the-oven baguettes at bakeries around China. By the end of 2017, Reward had spent more than $360 million on eight French farms dotted across the Allier and Indre departments, and on a Los Angeles–based soap and lotion maker.

But Reward’s global business plans are unraveling from the inside out, not in France or Southern California, but with a bond default in China that triggered a cross-default in the U.S. dollar debt market.

Concerns over the fate of such Chinese global holdings — from insurers and pharmaceutical companies to an Italian jeweler and the U.S. theme park SeaWorld — highlight how China’s domestic financial difficulties now have the potential to ripple through international markets.

The regulatory environment has completely changed.

Owen Chan, managing partner, Hogan Lovells

“When they did the deal their balance sheet looked good, but they bit off more than they could chew,” says Violet Ho, head of the greater China business intelligence and investigations practice of Kroll, a global risk consultancy, of a common trend for Chinese overseas acquisitions in recent years. “Now companies may have to write off transactions and back out of deals. People are going to lose a lot of money in the process.”

Chinese companies spent just over $1 trillion on overseas assets and construction during the five years between 2013 and 2017, an unprecedented spree that nearly doubled over the prior five-year period, according to data from the American Enterprise Institute’s China global investment tracker. Most of those investments have remained stable, with the exception of several large corporations — most notably HNA Group and Anbang Insurance — that have been forced to unwind tens of billions of dollars in deals.

But over the past six months, a series of midsize companies that fervently joined in the buying boom are showing signs of distress as credit tightens. Some have already been forced to let go of their overseas prizes. In August, Chinese group Sanpower lost control of House of Fraser when the high-end U.K. retail chain it bought in 2014 fell into administration – it came under the management of a court-appointed administrator after being declared insolvent. Sanpower opened restructuring talks with local banks last year but still owns several overseas businesses, such as U.S. retailer Brookstone and U.S. biotech company Dendreon.

“The regulatory environment has completely changed,” says Owen Chan, managing partner in Hong Kong at Hogan Lovells, a law firm. “It’s very hard to get money outside of China, even if you are a parent company trying to inject cash into an offshore subsidiary.”

Many other Chinese companies showing signs of financial distress have clung to their global holdings. In September, Gansu Gangtai, the parent of a company that owns Italian jewelry maker Buccellati, missed a payment on a Chinese bond. At the end of 2018, a unit of the Chinese owner of SeaWorld, Beijing-based commercial property developer Zhonghong Zhuoye, was forced to delist from the Shenzhen stock exchange due to the poor performance of the security. Zhonghong also owns U.S. travel company Abercrombie & Kent.

The woes at the Chinese companies are closely linked to the tightening of credit in the country as regulators attempt to slow the growth of corporate debt. Total social financing, a broad gauge of credit growth in China, has been falling since late 2016. In December, total social financing grew by just 10.2 percent, down from more than 15 percent two years earlier and more than 33 percent in 2009.

The squeeze on credit is evident at many new global companies such as Reward Group. Hu told Chinese media the missed bond payment occurred because a Chinese bank had withheld a new loan that would have been used to pay the debt. The company did not respond to a request for comment on the matter. But analysts have speculated the company could sell some of its French wheat fields to produce the needed cash.

“Since that spurt of aggressive buying a few years ago, liquidity has become much tighter,” Keith Pogson, EY’s global assurance leader for banking and capital markets, says of Chinese companies. “Their ability to access the debt market and even bank loans has become difficult.”

When Chinese companies are turned away by banks they often head to the higher-priced shadow banking market, or off-balance-sheet funds channeled through trusts and other intermediaries.

But access to this market is shrinking too. While still massive at RMB 62.1 trillion ($9.2 trillion) at the end of September 2018, shadow banking now amounts to 70 percent of China’s annual gross domestic product, down from 87 percent at the end of 2016, according to Moody’s. Trust loans, one component of shadow banking, fell about 5 percent, to RMB 8.1 trillion in September, from a peak at the end of 2017.

That impact is manifesting itself on balance sheets at companies such as Tahoe Group, a Chinese property developer that bought Hong Kong insurer Dah Sing Life for $1.4 billion in 2016.

From the start of 2016 to mid-2018, Tahoe’s trust debt grew 391 percent from RMB 13.7 billion to RMB 67.3 billion, equal to about 44 percent of its total debt of RMB 154.5 billion, according to REDD Intelligence, a corporate data provider. Far fewer trust products have been issued over the past year, making it difficult to get more of the same debt.

“With the tightening of trusts, they will probably have trouble getting access to more trust loans,” says REDD analyst Xavier Dong, who estimated in September that Tahoe’s cash on hand and unused bank facilities would not be enough to cover its short-term debt of RMB 56.2 billion, putting it on precarious financial ground.

It was unclear how a default at Tahoe would affect its Hong Kong life insurance operations, and the company did not respond to a request for comment.

But Dong notes that offshore assets, in cases such as these, could soon become lifelines for struggling Chinese companies.